Optimal Interest Rate Policy in a Small Open Economy / Eric Parrado, Andres Velasco.

Format:

Book

Author/Creator:

Parrado, Eric.

Contributor:

National Bureau of Economic Research.

Velasco, Andres.

Series:

Working Paper Series (National Bureau of Economic Research) no. w8721.

NBER working paper series no. w8721

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2002.

Summary:

Using an optimizing model we derive the optimal monetary and exchange rate policy for a small stochastic open economy with imperfect competition and short run price rigidity. The optimal monetary policy has an exact closed-form solution and is obtained using the utility function of the representative home agent as welfare criterion. The optimal policy depends on the source of stochastic disturbances affecting the economy, much as in the literature pioneered by Poole (1970). Optimal monetary policy reacts to domestic and foreign disturbances. If the intertemporal elasticity of substitution in consumption is less than one, as is likely to be the case empirically, the optimal exchange rate policy implies a dirty float: interest rate shocks from abroad are met partially by adjusting home interest rates, and partially by allowing the exchange rate to move. This optimal pattern may help rationalize the observed fear of floating.

Notes:

Print version record

January 2002.